The end of the empire
Much as I don’t like to admit it, the end of the US empire was accurately called 30 years ago by Coca Cola salesman Warren Buffett.
In 1990 he raised the alarm about net international investment in America turning negative, noting that America was being “sold out” to foreigners.
- You are the issuer of the globally dominant currency.
- Everyone in the world loves it, so they are willing to hold it as part of their international, or personal, reserves.
- The only way this can be true is for the issuer to run massive trade deficits. i.e. export more dollars than you import.
Very simply, the USA prints some USD, foreigners keep it and send goods in exchange. America gets materially rich, everyone else holds lots of dollars. It is a very good deal for America, for a while.
In the end though, there are so many dollars overseas that foreigners begin using them rather than hoarding them and they start buying America. As you can see in 1989, that’s what happened, America went up for sale.
That was the moment it ended, America started getting poorer and it accelerated from there. Please travel to one of their international airports and tell me it is a wealthy country. It is in fact an average country, home to some incredibly wealthy people.
It matters only because their currency is still so important in world trade and that is becoming a problem. When the USD ruled the world, everyone was happy to trade in it and hold it, now it is wobbling and that isn’t true. Everyone is looking for an alternative. Everyone from drug dealers to the European Central Bank.
I don’t give the guy much credit because I don’t like him, but Buffett called it 30 years ago. He was spot on.
The extent of the confidence wobble is quite profound, as we will see. Right up until the end of 2019 one of the most consistent features of US Treasury Bills was that overseas holdings far exceeded those held by the Fed itself.
In the space of 3 months in 2020, the Federal Reserve became the biggest holder of US Treasuries. More than China, more than all other countries official holdings. It will be a moment studied in economic history for a long time.
This change was characterised by the Fed as “a disruption in the normal operation of the treasuries market”. Which means, nobody could offload US treasuries at any price and the interest rate was about to go through the roof. A situation so severe that we saw an intervention of $2.5 trillion, roughly 12% of US GDP. Who cares? Actually, almost nobody but it is a lot and one day people will care.
The issue of course is more serious than the existing pool of government debt. 2020 was absolutely awash with US treasury issuance and foreign investors and central banks in Asia and Europe didn’t increase their holdings at all. Indeed, the biggest trading partner for the US, China, has reduced its holdings.
(As an aside, this is how China is paying for the Belt and Road initiative. They previously used their excess US Dollars to buy US Treasuries, now they build 3 lane highways in Nigeria.)
We are five days out from Biden’s inauguration. It is almost certain that he is about to give $2000 to something like 250 million eligible citizens. That is $0.5 trillion they do not have. Who will buy this debt? Who will buy the rest of the likely $3 trillion deficit Biden will run up in 2021?
The Fed cannot directly monetise, so they will work it through their proxies, the US banks. As follows:
- Federal reserve calls US banks “Make a market in these bonds – we can’t act in the primary market”
- “OK Gov, what’s our clip?”
- “It’s 0.01%, but please smile, wear a suit and make positive noises about the economy”
- “OK boss”
- US banks buy all debt issuance
- QE continues: Fed says – “We are buying more debt to help the economy recover and keep interest rates low”
- In the secondary market the Fed starts buying bonds from the banks
- The banks make their clip of the ticket
- Honour is maintained and JP Morgan makes $200 million for taking no risk at all
- The man and woman in the street benefit too, the lower interest rates help them……actually it doesn’t really help them because most Americans own absolutely nothing, and credit card rates stay the same. It sounds good though
- Simultaneously, whatever savings they do have start to melt in their hands
That’s the system, and not just in America of course. I hope you like it.
Still in the USA, a most unexpected announcement last week from the Office of the Comptroller of Currency.
Banks are now approved “to treat public blockchains and stablecoins as another form of settlement infrastructure”.
In effect this is like saying a blockchain is the same as the SWIFT network or ACH in the US. It is quite the surprise and very good news indeed.
This might lay the groundwork for a “digital US dollar” or the US equivalent of China’s Central bank digital currency, which is currently in test.
The success of Tether, the largest USD stable coin has no doubt made people sit up and listen. Tether now has a market cap of $22 billion, still small but growing and only slowed by regulatory hurdles and the difficulty they have getting bank accounts to store their value.
Perhaps most interesting of all was a statement from the OCC Chief, Brian Brooks, earlier in December:
For most of bitcoin’s 12 year life, outright ban has been a significant risk. The probability associated with that risk has now dropped, a lot.
A regular feature of bitcoin has been the strong pull-backs in price. I shared this chart last year showing how the progression from the 2016 halving was punctuated by multiple falls over 30%. It’s worth a reminder.
This time around the corrections look slightly less severe, closer to 20% but there is a long way to go and no doubt we will have steeper drops along the way.
Rules for you, not for me
Back in the 1990’s a scandal was brewing in France. A politically well connected billionaire called Bernard Tapie sued a majority French state owned bank, Credit Lyonnais. The detail isn’t terribly important but he alleged they had defrauded him out of €1 billion worth of Adidas shares.
At the time he was a big political supporter of Nicholas Sarkozy who was running for re-election to the French Presidency.
The case did not go to court. It was referred, with the help of the then President, to a very rarely used arbitration panel. That panel, behind closed doors, decided to settle with Tapie and pay him €400m from the state coffers. He then proceeded to be nice and helpful to Mr Sarkozy, who lost the election anyway.
Amidst all of this, an old friend. Christine Lagarde. At the time she was French Finance Minister and a friend of Mr Sarkozy, she approved the final payment despite the apparent conflict of interest.
None of this looked good and when Sarkozy did lose, the new government launched a corruption investigation. By 2016 the participants, including Christine, were in court. Guess what, they found her guilty (much to her surprise) following a week long trial.
I raise this because Lagarde was back in action this week accusing bitcoin of “funny business” and calling for global regulation.
The regulations, whatever they may ultimately be, will apply to you and me but Christine won’t care because she won’t think they apply to her.
Incidentally the court, despite finding her guilty did not fine or jail Lagarde. She received no penalty at all, which I and plenty of French people found rather odd. Not only that, she was rewarded with the job of President of the ECB.
At the time of her conviction she was head of the International Monetary Fund. It was a bit embarrassing for them because of course her predecessor, Dominique Strauss Kahn (remember him?) had been arrested for the alleged sexual assault of a hotel maid in New York. He settled out of court.
They understand “funny business” only too well.